company for company data snowflake (SNOW -3.29%) had its initial public offering (IPO) in September 2020, and it was perhaps the busiest IPO of all time.
Consider Warren Buffett saying his company in 2019 Berkshire Hathaway did not buy OverInitial public offering. As he told CNBC at the time, “I don’t think Berkshire has ever bought a new issue in 54 years.”
But a year later, Berkshire Hathaway bought Snowflake’s IPO, and that vote of confidence from famous investors prompted many others to get into the stock as well.
The hype was so great that Snowflake’s shares were trading at $245 per share, even though the IPO price had been $120. And it closed its first day of trading at nearly $254 per share. For the sake of simplicity, let’s assume you bought Snowflake stock at $250 per share on day one. With an investment of $10,000, you bought 40 shares.
Those 40 shares of Snowflake are worth just $6,507 as of this writing. Therefore, after more than two years, this IPO investment is down about 35%. And there is a good explanation as to why that is.
Snowflake Buzz: explosive revenue growth
Snowflake provides software that enables companies to store, analyze and monetize their corporate data. And its services are experiencing rapidly growing demand. For fiscal 2021 (ended Jan. 31, 2021), Snowflake’s revenue increased 124% year over year.
That growth hasn’t stopped since the company went public. Total revenue increased 106% in fiscal 2022. And for the first three quarters of fiscal 2023, revenue grew 77% year over year.
After all, Snowflake is a leader in an industry that many research firms believe represents a huge growth industry for the decade ahead, and that’s why management is so optimistic about its future.
Snowflake management expects its earnings to grow at a compound annual growth rate (CAGR) of about 32% through the end of fiscal 2029. Given that the company has already generated about $2 billion in annual sales, that’s massive growth at scale — no wonder investors went crazy over Snowflake’s IPO.
At this point, however, I’ll reinsert Buffett into this discussion. Snowflake’s growth has undoubtedly been amazing. But in a letter to Berkshire Hathaway shareholders in 1982, Buffett said, “For the investor, paying too high a price on a great company’s stock can negate the effects of a decade of favorable business developments to come.”
When it hit $250 per share on the first day of trading, Snowflake’s market cap was already over $70 billion. But the company had generated less than $500 million in trailing 12-month revenue at the time. This pushed Snowflake’s price-to-sales (P/S) rating above 140 — perhaps the highest I’ve seen for such a large company.
To me, Snowflake’s stock valuation was just too high when it went public, even after factoring in a decade of the most optimistic growth forecasts. So it’s not surprising that the stock has fallen since going public, although it continues to report sensational numbers.
what about now
Certainly, having fallen to a market cap of around $52 billion as of this writing, Snowflake’s valuation has become much more attractive. But on an absolute basis, it’s still very expensive, especially when you look at free cash flow (FCF).
If all goes according to management’s plan, Snowflake will generate $2.5 billion in FCF in fiscal 2029. Some investors think a stock is expensive when it’s trading at 20 times FCF. But Snowflake shares are already trading at more than 21 times what they forecast for FCF in about six years.
I’m not necessarily saying Snowflake stock is a bad investment based on its valuation today. As a general observation, I find that high-quality companies tend to pursue new revenue growth opportunities in areas that investors don’t anticipate. And Snowflake is a quality company in my opinion. As such, it may outgrow management’s already high guidance.
Additionally, Snowflake’s business is already FCF positive with adjusted FCF of $305 million for the first three quarters of fiscal 2023. And it’s poised to generate billions of dollars in cumulative FCF over the next decade. That’s a lot of money at management’s disposal. With good allocation, it could create tons of shareholder value.
What Snowflake stock doesn’t offer investors today is a high margin of safety. In my view, to outperform the market, the company needs to beat management’s current guidance, and management needs to be great allocators of capital. Neither is given. For that reason, I’ll remain content to watch Snowflake stock from the sidelines for now.
Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Snowflake, and Uber Technologies. The Motley Fool has a disclosure policy.
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